As summer winds down, Washington is again engaging in everyone’s favorite game of “Do we raise the debt ceiling?” Once a non-event with little media coverage, the debt ceiling debate has now become a manufactured crisis of sorts and a veritable political hot potato. While no one is quite sure what the economic implications of hitting the debt ceiling could be, it’s believed they are catastrophic enough that every time the fight comes up, it makes headlines.
So, all this rigmarole begs several questions, which we hope to answer here.
What is the debt ceiling?
When the Federal government runs a deficit, it must borrow money to fund the difference. This is usually done by issuing Treasury securities. Currently, the total U.S. government debt is just shy of $20 trillion – more than 100% of GDP! That is the level to which the government can borrow. To exceed that level, the debt ceiling must be raised by Congress. Otherwise the Treasury will run short of money to meet payroll, issue Social Security checks, etc.
Why does it exist?
The debit ceiling was first implemented in 1917 when we entered World War I. Prior to that, Congress had to authorize each loan issued by the Treasury. However, the law was changed so that the government could more easily issue bonds to fund the war effort. The new law allowed the Treasury to issue bonds up to but not exceeding a debt limit (ceiling). At first, there were multiple debt limits for different types of debts. In 1939, the multiple limits were combined into the one debt ceiling we know today.
Does raising the debt ceiling allow the government to spend more money?
The short answer is no. Not raising the debt ceiling is akin to not paying your credit card. The balance on your credit card represents money you’ve already spent. Same with the debt ceiling. The deficit and the debt ceiling are often seen as interchangeable, which is incorrect. The deficit represents a new shortfall that the government must borrow to cover, resulting in new debt. The debt ceiling represents money already borrowed.
What are the consequences if the government hits its borrowing limit?
No one quite knows as it’s never happened. However, one thing is clear. If the U.S. can no longer borrow, it may have to stop paying its bills. That could slow down the economy. Another concern is that confidence in the U.S.’ credit-worthiness could be affected. This happened in August 2011 when Standard & Poors downgraded the U.S. from AAA to AA+ just because the debt ceiling fight spooked investors.
Why is raising the debt ceiling so controversial?
Although not related to the level of government spending, the debt ceiling has become a flash point for those in Congress who want to reduce deficits or shrink the size of government. Whenever it comes time to raise the debt ceiling, the fiscal hawks in Congress endeavor to tie such an increase to a reduction in ongoing spending. In general, such a tactic has not worked and eventually the ceiling is raised, albeit in many cases at the last minute. This uncertainty can rattle markets.
The fact is that since the debt ceiling was implemented, it has been raised 84 times without fail. So, what used to be routine has now become controversial. Unfortunately, as long as politics are at play, unless the whole notion of the debt ceiling is abolished (as some would like it to be), we are likely to endure additional debt ceiling dithering in the months and years to come.